Nice! Old Wall Has Second Thoughts About Fed's December Rate Hike

Is the Fed tightening into an economic slowdown? That's the latest question macro market consensus is grappling with this year.

For months now, Hedgeye CEO Keith McCullough has been vocalizing his concerns about flagging U.S. growth while Wall Street all but cheered for a Fed rate hike in December.

Watch McCullough Explain our thinking on Fox Business:

Old Wall is now having second thoughts. Here's the latest summation of macro consensus from the Financial Times:

"... The long-awaited rate increase went smoothly, but simmering concerns over China, the global economy as a whole, deflating commodities and financial market valuations have since risen to the fore. Even fund managers that were relaxed about slightly tighter monetary policy last month are now wondering whether that was complacent."

We've been arguing our Macro themes global #GrowthSlowing, #Deflation and #LowerForLonger (rates) for a while now. It appears those realities are slowly dripping into Old Wall consciousness this year, even though we've held them forth for more than 18 months now.

... And Watch out!

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Recession Watch | WSJ: "This Time Is Different," Hedgeye: "Nope"

Notwithstanding the headline, the story is seemingly amenable to one of Hedgeye's latest Macro calls – the increasing likelihood that the U.S. slips into a #Recession in 2016.

Then, about halfway down, WSJ holds up the old "ex-Energy everything is fine argument." That was Old Wall's favorite line last year for explaining away why client equity portfolios were crashing. It's false.

Here's Hedgeye CEO Keith McCullough in the video below on this ex-Energy fallacy.

Now, the WSJ hangs the rest of its analysis on the jobs market – which is "growing briskly" – and supposedly strong consumer confidence. The mistake here is in confusing absolutes with what really drives macro markets and is ultimately more predictive – rate of change.

In the video below, McCullough also dispels of these consumer confidence and jobs market narratives.

INSTANT INSIGHT | Oil, Volatility & Old Wall Storytelling

Takeaway:Last week's two day rally in equities was not the bottom for which so many were hoping.

Beware the bounce.

No, last week's two-day rally was not a sign that the equity crash bottomed out. Heightened volatility should continue to ravage financial markets.

Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:

"... After a 2-day bounce in oversold beta all of the bottom callers came back, but day 2 of that came on one of the lightest US Equity Volume days of the year (-9% vs 1-month average). Front-month VIX didn’t come close to breaking any lines of support."

On a related note, Oil volatility is ramping too, as crude prices continue their downward descent this morning.

"Oil led the bounce (that hasn’t been a good thing for 18 months) +5.9% on the week for WTI, but is straight back down -3% this morning after failing at all lines of @Hedgeye resistance – risk range there = $28.21-32.68; Oil Volatility (OVX) = 62!"

Keep your head up out there and beware of Old Wall's shape-shifting storytelling.

Takeaway:China's slowdown continues to grip markets, the ECB is investigating NPLs across the Eurozone, and the Euribor-OIS spread rises a bit.

Key Takeaway:

Slowing growth continued to grip global markets last week. Data came out showing that Chinese 4Q GDP decelerated to 6.8% y/y from 6.9% in 3Q, driving CDS in the U.S., Europe, and Asia higher. Additionally, the Euribor-OIS spread, a measure of counterparty risk in the Eurozone, widened by +2 bps last week, and concern over non-performing loans has reached the point that the ECB announced it is investigating a number of Eurozone banks about their management of such loans. Italian Banco Popolare confirmed that it is undergoing such an investigation, and its CDS widened by +63 bps to 333.

Another measure of counterparty risk, which we have added to the bottom of our monitor this week, is the CDOR-OIS spread. It is the Canadian equivalent of the Euribor-OIS spread and measures the difference between the Canadian interbank lending rate and overnight indexed swaps. In other words, it measures counterparty risk in the Canadian banking system. The measure hitting a post-crisis high of 50 bps on January 15 prompted us to start tracking it. The spread has since tightened somewhat to 38 bps but remains elevated.

1. U.S. Financial CDS – Swaps widened for 10 out of 27 domestic financial institutions with an average change of +2 bps as concerns over slowing Chinese growth and low oil prices continued to drive risk concerns. At the bottom of our U.S. CDS table below, we have added indices on investment grade and high yield CDS, which tightened last week by -6 bps to 104 and by -31 bps to 525, respectively.

2. European Financial CDS – Swaps mostly widened for European banks last week. With low oil prices one of the driving factors in market weakness, Russian Sberbank CDS continued to be significantly affected, widening by +32 bps to 445. In Italy, Banco Popolare CDS widened by +63 bps to 333 as it announced the ECB is investigating the bank's management of non-performing loans. Additionally, in Portugal, with the issue of transferring risk between Novo Banco and Banco Espirito Santo remaining volatile, Banco Espirito Santo CDS tightened by -291 to 937.

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread widened by 2 bps to 14 bps.

13. 2-10 Spread – Last week the 2-10 spread was unchanged at 118 bps lats week. We track the 2-10 spread as an indicator of bank margin pressure.

14. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread tightened by 13 bps to 38 bps last week.

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT

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